Blog

28.10.2015

Saudi Aramco crude on the Baltic Sea – a one-off opportunity or new supply source?

A Saudi Arabian vessel carrying crude oil has recently put into port in Gdańsk. The event would have likely gone unnoticed had it not been for Rosneft CEO’s comment that it marked another stage in Saudi Arabia’s battle for a share in the market. Why has a small delivery sparked such a heated debate?

Saudi Arabia is one of the world’s three largest producers of crude oil and the largest exporter, and the Naftoport terminal and the Pomerania pipeline had been built to transport oil. The Płock–Gdańsk route, with an annual flow capacity of 27 million tonnes, carries oil from Russia to the LOTOS refinery in Gdańsk (and it also used to transport crude to be exported through the Gdańsk terminal). Higher by three million tonnes, the reverse, Gdańsk–Płock flow capacity is used by PKN ORLEN to transport oil purchased opportunistically and delivered to Poland by sea. In the past, Polish refineries relied primarily on Russian REBCO crude, with other types accounting for a small portion of the slate. The reason for this is fairly obvious. For refineries in Poland and other countries in the region (Lithuania, the Czech Republic, Hungary, Slovakia, Germany), Russian REBCO is a merit choice for technological (facilities best adapted to process this crude variety) and logistical reasons (direct pipeline connection), which also makes it attractively priced, all the more so since REBCO is typically sold at a discount to Brent crude (Urals/Brent differential). One may then say that the refineries used Russian crude out of their own choice rather than because there were no alternatives or due to logistical constraints. For many years, the PKN ORLEN refinery in Płock has had the technological capabilities to process many alternative crude types available on the market. The full list of crude oil types we have tested in processing contains close to 100 varieties and is still growing. This high level of processing flexibility was achieved following upgrades of refinery installations. The facility in Płock is now ranked among the most advanced refining complexes in Europe, called supersites. Switching over to process other varieties of oil, delivered by sea, is easy and enables the refinery to produce appropriate fuel volumes at reasonable cost levels. Our Lithuanian refinery in Mažeikiai has had oil deliveries this way from the very beginning through the Baltic Sea Būtingė Terminal. The Płock refinery could also work in a similar manner and draw its oil supply through the Pomerania pipeline from the seaport.

According to a 2014 report by the Polish Organisation of Oil Industry and Trade (POPiHN), Polish refineries processed 24.3 million tonnes of crude in 2013, 93% (22,7 million tonnes) of which was Russia-sourced oil, with 85% (19.3 million tonnes) reaching the refineries through the Druzhba pipeline and 15% (3.4 million tonnes) by sea – through the Naftoport terminal. Other types of crude delivered by sea accounted for no more than one million tonnes. Can these proportions change in the years to come? Before I answer this question, let us again consider the economics of the oil market, which is transforming before our very eyes thanks to several new phenomena, such as:

Increase in recoverable oil reserves in North America and a material, on a global economic scale, increase in oil supply;

Shortening of the reaction time and an increase in strength of the global supply’s response to oil price changes due to less time being needed to extract the additional (marginal) several percent of global oil supply (down from several years to 90 days), and

These developments have resulted in a change of the pricing mechanism on the global oil market, from OPEC-managed to market-based, in which prices are equal to marginal costs (3 to 4 MMbd of the most expensive oil for which there is demand). In these circumstances, it no longer makes sense not to extract oil which can be produced at a cost below its market price. Marginal barrels of oil, which certainly do not include Saudi crude, are an exception. Let me note that the lion’s share of the production reserves maintained by OPEC belongs to Saudi Arabia. Thus, adjustments on the global oil market also entail a significant reduction in OPEC’s production reserves, which have already dwindled from 3 million barrels per day in 2014 to 2.4 million in 2015 and are on their way to 2 million barrels over the next two years. We cannot discount the possibility that when the market absorbs the surplus supply and the price of oil begins to grow, OPEC countries revert to the short-term price management strategy, since managing prices over a longer term will no longer be effective due to production in the US being adjusted to price levels.

What is the conclusion? Saudi Arabia’s strategy is not to maintain its market share, but to increase it so as to be able to reduce the production reserve. And to grab a larger share of the market, Saudi Arabia must look for new markets, even if they are far away, and sell its oil at a lower price, compared to benchmark crudes, than its competition. The Baltic region, which has traditionally been the domain of other players, might be just that for Saudi Arabia’s oil company ARAMCO. The region’s refineries, which already process sea-born crudes (15 in total, with a combined annual throughput capacity of some 134 million tonnes) represent considerable potential, which exporters are aware of. Meanwhile, refinery operators, conscious of the fact that the time of high margins is nearing its end, take every opportunity to purchase cheaper oil to create a buffer afforded by larger differentials. This is simply economics at work rather than a change of strategy towards Russian suppliers.

To sum up, we have many reasons to believe that these ‘opportunities’ may well become a steady stream of competitive supplies from Saudi Arabia, as well as from Iran, which will offer a viable alternative to Russian oil in the near future. A similar thing can also happen elsewhere around the globe. Rosneft CEO has clearly seen the risk.